Why Google's Shopping Spree Should Worry Investors

In October, Google (GOOG) CEO Eric Schmidt told investors his company would be on the lookout for acquisitions. But few could have predicted the shopping spree that has since materialized.Google is about to snap up local information company Yelp for $500 million. That purchase comes on the heels of a $750 million takeover of AdMob in November. Google may also now be in the process of buying online real estate information company Trulia for northwards of $200 million, according to some reports. There have also been smaller deals, like the November purchase of ad optimizing company Teracent or a possible acquisition of document collaboration company DocVerse for about $25 million, according to some reports.

%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%%But while Google is chasing down some of the hottest upstarts around, its buying binge should give investors serious pause. Recall that the search giant has an army of engineers on hand, who famously have 20% of their time carved out to work on pet projects that might blossom into the Web's next big thing. Indeed, investors are often concerned about Google's massive spending on hiring. So, having to pay top dollar for other companies demonstrates Google's inability to take advantage of emerging Web trends itself, despite devoting major resources to the cause. And buying other companies has yet to solve that problem, either.

Oops, Missed That . . . and That

Hypergrowth companies like Facebook and Twitter -- the latter was started by former Google employees -- blossomed right under Google's nose. Facebook flourished, while Google's own social-network play, Orkut, has struggled to gain traction. And while some are now calling on Google to shell out $1 billion for Twitter, the micro-messaging start-up's success begs the question of why Google didn't come up with a similar service itself. After all, most investors see buying Google as a ticket to participate in the ever-evolving Internet. And as expansion of Google's core search product -- which still accounts for 95% of its revenue -- slows sharply, the company desperately needs new growth prospects if more investors are going to get on board. Shares still trade shy of $600, a level they first approached more than two years ago. And at 23 times forward earnings, shares trade a big discount to the 34 multiple commanded by struggling rival Yahoo (YHOO). Indeed, the 1.25 price-to-earnings-to-growth multiple for Google is almost exactly the same as that for the stalled eBay (EBAY), a signal of investors' skepticism.

And while Google has been struggling to build, its attempts to buy the next big thing have hardly been winners. Despite spending $3.1 billion for ad-serving company DoubleClick more than two years ago, Google has yet to become a force in the display-ad market that sits adjacent to its search products. And the company still hasn't found a way to turn a profit on its $1.6 billion purchase of video-sharing company YouTube, despite the service's popularity. Other start-ups Google bought, like Dodgeball and dMarc -- a radio ad company that Google spent $102 million on, have since been scrapped.

Wait for Some Evidence of Success

Of course, the game is hardly over for Google. The company's Android mobile operating system shows great promise and may put Google in a position to replicate its search success in the lucrative mobile-computing market. And despite some dismissive reviews, the company's Wave collaboration platform could take hold as well.

But investors should sidestep the hype that surrounds Google's acquisition of a hot start-up. Instead, they should look for a homegrown product to be a hit -- or at least for a prior purchase to work out as planned -- before placing bets on Google.